Japan -Y2K and Financial Problems

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This from Market News International For Educational/Research Purposes Only

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JAPAN OFFL: JGB LIQUIDITY POOR AMID Y2K FEARS, PRICE WOES

--Originally Transmitted At 08:08 GMT Today

By Matthew Saltmarsh

HONG KONG (MktNews) - Liquidity in the Japanese government bond market is still weak, although better than it was, because various players are wary of Y2K trading risks and due to recent pricing anomalies, a ranking Ministry of Finance official confirmed to Market News Thursday.

The official denied reports that there is an ongoing "strike" in the market by some foreign and domestic players due to Y2K and supply fears. But he did acknowledge that various foreign and domestic players are running shy of the market at the moment.

The "strike" was reportedly because of recent price declines and fears the bond markets could face liquidity problems at year-end because some large institutions will stop lending bonds over the millennium for trading purposes as they fear some customers' computers will crash.

"It's not a strike," the official said. "It's some kind of mis-relation between the cash market and futures market and the background is they say there is a Y2K problem."

"Market-making is now very difficult for traders in the JGB market especially in the cash market, but I don't think there is some kind of strike," he said.

Players say one problem is due to a structural reform which is planned to take place in the markets next March to make the March futures contract more attractive. This has left investors rushing to buy the March contract instead of the September or December contracts.

This was confirmed by the official who said the problem has been on-going for several months.

"From May or June, the JGB futures market had some problems. The cheapest to deliver for June 1999 and also September and December were 20-year bonds for the 10-year (future) so there was not enough liquidity in the cheapest to deliver for those futures," he said.

"So some market participants were reluctant to use JGB futures, but now the market participants use the March 2000 future and the cheapest to deliver for that is 10-year bonds because the Tokyo Stock Exchange has changed its rules to exclude 20-year bonds (from delivery)."

He added "more and more" market participants are using the March 2000 future to hedge their cash positions "so the price of (other) futures is too low and the correlation with the cash markets is lost and market participants have lost their way to hedge their cash positions."

Analysts have also pointed out that a problem plaguing the efficiency of the JGB market is the lack of liquidity in the repo market as a lot of off-the-run issues are controlled by one party and they can distort prices by holding back from lending in the repo market.

Consequently, a way around this for the Bank of Japan and/or the Ministry of Finance to agree to either lend bonds when needed or to just reissue some of the outstanding bonds instead of offering new ones, analysts add.

"The problem has a psychological aspect to do with Y2K and we and the BOJ do not see this problem related to Y2K so if we can persuade market participants that there is not any problem in the bond market relating to Y2K then they can come back."

"One or two weeks ago the situation was worse than now. I think the situation is becoming better and better," he said. "I would not say I have no concerns but I have fewer concerns."

The official also acknowledged that supply concerns and general uncertainty about the economic outlook could be hampering liquidity.

Meantime, some players also point to the accounting system, which appears to encourage Japanese banks to withdraw from JGB markets when they record losses on their bond portfolios.

Separately, the official confirmed that the MOF's Trust Fund Bureau will continue buying JGBs, probably until the end of the current fiscal year.

The MOF said Wednesday it would not sell JGBs, attempting to avert fears of additional issuance hitting the market.

Fears were raised when the Post and Telecommunications Ministry -- one of the largest purchasers of JGBs -- said it would lose Y21 trillion in deposits during the two years through 2001 because depositors will probably reinvest some of their money from maturing 10-year deposits in higher-yielding securities. This prompted concerns that the Post would have to scale back its purchases of JGBs.

Asked if Trust Fund Bureau buying in the secondary market will continue for this financial year, he said, "I hope it will continue to the end of this fiscal year...probably."

The MOF currently buys Y200 billion of government bonds each month in the secondary market. --Market News, Hong Kong ( tel 852-2528-6038) email matthew@mktnews.com

07:16 EDT 08/26

) 1999 Market News International, Inc.

-- Mike Lang (webflier@erols.com), August 26, 1999

Answers

Which government does this sound like?

"The problem has a psychological aspect to do with Y2K and we and the BOJ do not see this problem related to Y2K so if we can persuade market participants that there is not any problem in the bond market relating to Y2K then they can come back."

Please come back...really everyone is compliant...there's no need to panic or prepare.

-- nothere nothere (notherethere@hotmail.com), August 26, 1999.


So here's how it works. In Japan, they have a large "savings bank" system called the Postal Savings System. Basically you can put money into a savings account at your local post office. Not surprisingly, most Japanese contribute quite heavily to these (called Yucho), so the PSS is normally a big gorilla buyer in the bond market, the Japanese Govt Bond market. This is because they have huge amounts of Yen comming in.

Now, recently the PSS stated that they were expecting some rather large redemptions, in fact huge redemptions, 31 trillion yen. Hmm, wonder why the Japanese consumer is taking yen home to stuff under his pillow? Then you've got the Jap. government and the banks. The banks in Japan typically are large holders of JGB's as well. They sometimes avoid sale of the bonds when they're under water. This seems to be the case right now, to the point where US banks are complaining to the Japanese govt. about it. The Japanese govt. has NO desire to rock the boat as they are currently playing a game called, "Look how well our economy is doing". Add to this the fact that the insurance companies are certain to retain large cash positions (JGB's) and you have a recipe for disaster. Lots of sellers in an increasingly illiquid market.

In the mean time they hold a bond auction yesterday during which no one wants to buy bonds. Adding to the problems are the fact that the govt. was planning a rather large auction in the fall, to put some juice into the economy over there.

Without it, the economy go's sour. Unfortunately since the players are thinking the JGB market could be hosed, they are gonna have a hard time floating that debt.

Damned if you do, damned if you don't. Yikes! This is the first shot fired in the comming commercial wars. My guess is that governments will be quite taxed in terms of fiscal capacity. There are no precedents for an economic event such as this, and in our tightly bound markets, mis-steps will be treated quite harshly.

For educational and research purposes only:

TOKYO, Aug 26 (Reuters) - Japanese government bond (JGB) futures were lower in early Tokyo on Thursday, weighed down by fears that an expected massive outflow of Japan's postal savings (Yucho) deposits would result in a deterioration of the demand-supply balance in the JGB market. But the key contract quickly pared losses as some investors bargain-hunted cash JGBs after seeing the 10-year yield rise above 2.0 percent, traders said. The March contract was down 0.10 at 127.80 at 0050 GMT, after earlier falling as low as 129.39. The yield of the September 215th 10-year JGB was at 1.975 percent, down from 1.995 percent late on Wednesday. It earlier rose as high as 2.040 percent before buying was detected from Japanese investors. "Buying emerged in the cash JGB market as the 10-year yield rose above the key 2.0 percent level. But sentiment isn't any better. People are still worried about the demand-supply balance," said a trader at a Japanese brokerage. The March contract dropped as low as 127.27 overnight on LIFFE after Japan's Posts Ministry said late on Wednesday that it expects a total net outflow of 31 trillion yen worth of Yucho deposits in fiscal 2000/01 and 2001/02. A senior Finance Ministry official said late on Wednesday that the ministry is not currently planning to sell to the market JGBs held by its Trust Fund Bureau despite an expected exodus of Yucho funds, which is the Bureau's major fund source. The Bureau currently purchases about 200 billion yen worth of JGBs outright from the market each month. A trader at a Japanese bank's securities unit said: "A lot of people are sceptical that the Finance Ministry could really refrain from turning into a JGB seller when Yucho outflow starts." The 10-year JGB could edge higher towards 2.2 percent in the near term, the trader said. ((Tokyo Treasury Desk, +81-3 3432 9780

-- Gordon (g_gecko_69@hotmail.com), August 27, 1999.


Gordon, can you translate the fiscal calendar dates 2000/01 and 2001/02 for the fiscally impaired. Is there any other reason besides Y2K why the Yucho money is expected to be negative then? Is this a seasonal thing related to the Japanese equivalent of Christmas, or is this really unusual?

-- nothere nothere (notherethere@hotmail.com), August 27, 1999.

nowhere, I understand there is a maturity coming due on some 10 yr bonds that are paying a very good rate. The fear is this money(trillions of yen} may not be put back in the bond market. If anyone else can expand on this, please do as it will effect the market severely in the next few months.

-- Mike Lang (webflier@erols.com), August 27, 1999.

The following is an excerpt from PNG's site dated March 1999. That site is long gone, so I'll post this instead of posting a link.

Jerry

The world's largest financial institution is facing a ticking timebomb.

The largest financial institution in the world is the Japanese Postal Savings System. It was created in the mid 1960's as a convenient and safe system for "ordinary people" to invest in time deposits. In return, the government benefited from the steady cash deposits.

The original concept was that small-lot depositors would create a small financial institution. Japan was not a wealthy nation then and Japanese banks and government ofiicials continually drummed the concept of save, save, save to the Japanese consumer. And save they did. Today, the outstanding balance of Postal Savings is about 250 trillion yen (~U.S.$2.2 trillion). Those are trillions not billions.

You rarely see trillion dollar numbers thrown around because those kinds of numbers are reserved for people like Alan Greenspan when he talks about...whatever it is he talks about. I think he talks about gross domestic products. So, most people associate the phrase "trillions of dollars" with Alan Greenspan which means most of you are asleep right now.

The sheer size of Postal Savings makes it capable of affecting the entire global financial picture should any drastic changes occur. The basic financial intruments of Postal Savings are 10-year fixed-rate deposits. If you think back ten years ago, Japan was at the height of it's financial power and the inflated bubble economy.

In 1990, the Postal Savings was offering compounded annual yields of over 8.5% on ten-year deposits. Japanese "ordinary people" poured about $1trillion into the system. They subsequently withdrew about 40%, but the remaining balance with interest will come to maturity in 2000.

Starting in 2000, people will be lining up at post offices to redeem their 10-year bonds. Since rolling over into new fixed-rate Postal Savings deposits will yield only about 0.2% interest, I expect most will want to put their money elsewhere. How much are we talking about here? Well, we're talking about an Alan Greenspan amount of money...about $1 trillion dollars.

I know you're sleepy, but stay with me here. $1 trillion is about the same as the GDP's of Canada and Mexico combined.

So can you imagine all these Japanese housewives lined up at post offices with their savings books, asking for over 20% of Japan's GDP...in cash?

"Okane wo misete kudasai" (Show me the money)

Now, the question is...where is the money? Obviously the money is "invested." The problem is that much of it is "invested" in what are called "special corporations." Special corporations are businesses set up by the government bureaucrats to be run by former and retired bureaucrats. It is estimated that these special corporations have lost over $500 billion by allowing retired bureaucrats to pretend to be businessmen.

The Japanese government plan is to "hope" only half of the people want their money. Then perhaps they can sell $500 billion of more bonds to pay for the redemption of the first bonds. Bond prices could skyrocket for such a scheme.

If that isn't enough, consider that next year companies are required to report the status of employee retirement funds. Currently, Japanese companies are not required to disclose this information. Many very large companies do not have the abiity to meet their pension obligations to Japanese baby boomers who devoted their lives to companies in exchange for their retirement money.

The disclosure of corporate pension shortfalls could provoke 75% or more of Postal Savings investors to cash in their time deposits at maturity. There just isn't enough money to cover that scenario.

I have never been able to visualize a scenario that would prompt Japan to sell it's massive holdings of U.S. Treasury Bills. I'm starting to see a scenario now.

-- Jerry B (skeptic76@erols.com), August 27, 1999.



Thanks Jerry. I remember reading this when PNG first posted it but I had forgotten where I saw it. As you can tell it did make an impression on me.

Japan seems very frail at the moment and it could become a trigger.

-- Mike Lang (webflier@erols.com), August 27, 1999.


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